Economic and financial environment

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2003 was a year of recovery for the global insurance industry. Substantial non-life premium rate improvements raised the industry’s technical results, despite its need to strengthen loss reserves. The capital market environment improved, leading to better investment results and helping life insurers to sell their guaranteed interest products. 
 

Better capital market environment for insurers

By the end of 2003, the world economy had regained stability and appeared headed for a recovery. Earlier fears that other countries would follow Japan into deflation proved unfounded. Instead, the global economy recovered, spurred by strong growth in the US and – surprisingly – Japan. At the year’s end, interest rates were slightly higher than they had been a year earlier and stock market indices in most countries were up by more than 15% on their 2002 year-end levels.

Notwithstanding these improvements, high currency exchange rate fluctuations heavily impacted the balance sheets and the results of global firms for the second successive year. Most notable was the decline of the US dollar against the European currencies (EUR –17%, CHF –11%) in the course of 2003, which significantly reduced US dollar denominated income.
 
 


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Capital requirements remained an issue

The capital position of the insurance industry remained relatively weak during 2003, reflecting the financial difficulties of the previous years. Rating agencies continued to be sceptical about the outlook for the industry, further downgrading several insurance and reinsurance companies.


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Improved results in property and casualty insurance

Direct non-life premium volume grew strongly in 2003, although at a slower pace than in 2002, when growth rates were at their highest since the liability crisis of the mid 1980s. Growth was fuelled once again by further premium rate increases in many markets, particularly in industrial lines of business. Many commercial lines have seen prices increase by over 50% over the last four years.
 
Technical and financial results improved substantially in 2003. Primary insurers successfully returned to underwriting profitability by tightening policy terms and conditions and improving cost efficiency, as well as by increasing rates. Combined ratios in the major markets are therefore expected to decrease by three to seven percentage points from 2002 levels, additionally supported by a below average loss burden from major man-made disasters. Insured losses of natural catastrophes were slightly above the long-term average. Credit claims, which are heavily dependent on general economic conditions, also developed favourably in 2003.

Nevertheless, some adverse developments affected the 2003 figures and prevented the industry from registering even better financial results:

  • The latest data indicate reserves for liability claims were under-estimated, especially in the US and UK, highlighting significant under-pricing during the soft market in the second half of the 1990s. These reserves had to be strengthened, causing earnings from current profitable business to be reduced.
  • In some European countries, impairments to insurers’ assets, resulting from the equity market decline in prior years, were not fully recognised until 2003.

The reinsurance sector fared similarly: underwriting profitability improved considerably, especially in short-tail business. However, long-tail lines continued to be affected (albeit to a lesser extent than in previous years) by adverse claims developments.
 


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Gradual improvement for primary life insurers

The life industry continued to face a challenging environment in 2003. Although premium volume further increased in North America and Continental Europe, growth was well below the trend of the 1990s. The volatility of financial markets hampered sales of unit-linked policies and variable annuities. However, life insurers benefited from continued strong demand for private and occupational pension products as governments in many countries, particularly in Europe, grappled with pension system reform.

Profitability improved due to the more favourable investment environment in the second half of 2003 as well as the industry’s successful efforts to cut costs. However, cost reductions and lower bonus payments were not sufficient to bring life insurers back to past levels of profitability, for the following reasons:

  • Many life insurers today are tightly restricted in their investment strategies. They are no longer able to invest as heavily as they once did in high return securities such as equities, since they lack the capital necessary to absorb the higher risk involved. This is a fundamental problem for providers of life policies with bonus payments in markets such as the UK, Germany and Switzerland.
  • Unlike property and casualty insurers, which have far greater flexibility to reprice much of their business every year, many life insurers still carry a large in-force portfolio of policies offering investment return guarantees above the rate that can be earned in the current, historically low, interest rate environment.

Although the industry has generally managed to avoid defaults, a number of insurers still have weak balance sheets, indicating that some consolidation between market players will be inevitable.

Life reinsurers have typically concentrated on reinsuring the mortality and morbidity risks of life business, and are therefore less affected by the interest rate guarantees of the primary insurers.

Life reinsurance premium growth has continued to outpace primary growth in 2003, reflecting in part the fact that protection business has not experienced the same sluggish growth as savings-type products. However, growth slowed in 2003 – particularly in the US, which accounts for over 60% of global life reinsurance volume; cession rates there have now stabilised. New opportunities are expected to arise in Continental Europe as a result of the capital pressure facing life insurers.


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Outlook

Primary insurance premium volume in industrialised countries in both life and property and casualty is generally expected to grow with the long-term trend growth of GDP (between 3% and 4% per year), and premium increases in emerging markets will outpace overall economic growth. The underwriting result in the property and casualty insurance industry will remain attractive in most segments through 2005 at least, with combined ratios of approximately 100% for primary business; combined ratios for reinsurance are expected to be below 100%. Life reinsurance growth will exceed growth in primary markets in most countries, with the exception of the US and UK, where cession rates for new business are unlikely to increase beyond the current high levels.


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